The Perils of Marginal Trading for Crypto Traders

The former employee of Consolidated Trading LLC, Joseph Kim, faces up to 20 years in prison for losing more than $600,000 of the company’s funds on marginal trading on the crypto market. We figured out how marginal trading works and what the risks of this strategy are for new crypto investors.

What Is Margin Trading?

Marginal trading is one of the most profitable, but at the same time, the riskiest of strategies. In marginal trading, a crypto trader takes a loan from a broker, most often represented by an exchange, and provides collateral—the margin. At the same time, interest is charged for using the loan. But in this way, marginal trading allows one to buy a cryptocurrency in excess of the balance of the trader. To make a deal, a trader has a marginal account on the exchange, where funds act as a guarantee to the lender. A tool that allows one to trade amounts that exceed one’s own funds is called leverage.

The size of the maximum possible leverage is established by the organizers of the exchange. A 1:1 leverage means that the trader can take as much as they have. A trader with 1 Bitcoin on balance will trade 2 Bitcoins, thus increasing the potential profit. For example, the Bitmex exchange offers the option to trade at the 100:1 leverage. Under such conditions, one can either multiply their balance in a few minutes or immediately go bankrupt. Leverage trading is also offered by Bitfinex, CEX.IO, and GDAX.

There are two main options for marginal trading. The first is a long position, or a game of rises, when a trader bets that the price of a crypto asset will rise. The second is a short position, or a game of drops, when bets are placed on that the price of a cryptocurrency will decrease.

Marginal trading gives traders with little capital the opportunity of earning much more and doing it in a shorter period. The risks associated with marginal trading, however, are considerably higher. If the price of a crypto asset plummets while trading on the rise, then when it reaches a certain critical point, the trader may lose all of the deposit due to a margin call, or the forcible closing of the deal by the broker when it reaches a certain drawdown, if the trader has not added funds to the account. If the borrowed funds are under threat, the exchange has the right to deduct the loss from the deposit of the marginal account.

Nevertheless, there are cases when traders facing severe losses decide to raise the stakes to win back their positions instead of accepting their losses. This often leads to even greater losses.

How Joseph Kim Lost $600,000

Joseph Kim faced such a situation and lost more than $600,000 in two months on marginal trading on the crypto market. Kim decided, however, to redeem his losses at the expense of the company in which he worked, the Consolidated Trading LLC firm. When the crypto market was at the stage of unprecedented growth, the then-employee deducted more than $2 million worth of cryptocurrencies from corporate wallets.

In September 2017, Kim decided to earn on marginal trade on the cryptocurrency market. His strategy was to short Bitcoin and maintain the level of margin at the expense of cryptocurrencies his company held. Kim started with small amounts, but the more he lost, the larger the size of the next marginal transaction was.

According to official information obtained by the Chicago court, the company knew that from September to November 2017, Joseph Kim had transferred 980 Litecoins to his personal wallet, and after that another 55 Bitcoins, of which Kim returned only 27. The investigation uncovered that in just over two months, Kim transferred 284 Bitcoins, of which the company received back only 102. Kim said he made transactions with the company’s cryptocurrencies worth of hundreds of thousands of dollars, hoping to profit and cover borrowed funds:

“Until the bitter last, I was trying clumsily to correct the mistakes I had committed. I cannot believe that I did not stop when I had enough money to cover my debts. I will live with it for the rest of my life.”

The company managed to recover $1.4 million from the personal wallet of their former employee. $603,000, however, remained irretrievably lost as a result of the unsuccessful deals conducted by Kim. The court can sentence Joseph Kim to 20 years’ imprisonment.

Cryptocurrency Prices Are Driven by Many Factors

At the end of the last year, an anonymous crypto trader also shared his experience. Having foreseen the cryptocurrency’s rise in value, he utilized marginal trading to make 200 Bitcoins out of 3 Bitcoins he had invested initially. Nevertheless, a poorly planned strategy led him to losing all of his savings in one month’s time, when the bitcoin price fluctuated. A trader noted that his example should serve as a lesson for anyone who trades using risky strategies and sums that could change their lives.

Taking into account the fact that 30% of millennials aged 18 to 34 prefer investing in Bitcoin to investing in traditional securities, experts suggest that before trading, one should invest only after having realized all risks posed by such a volatile market and avoid taking advice from gurus and experts who offer “instant” revenues. Cornell University professor Emin Gün Sirer stresses that first and foremost, the traders on the crypto market should cease to listen to those who find easy answers in charts. Professor thinks that in order to understand the cryptocurrency prices, one needs to examine many factors, especially when selling short and trading on margin:

In the volatile cryptocurrency market, one needs to evaluate risks, analyze potential threats, make decisions with caution, and be prepared to lose 100% of their investments.

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